Markets have traded with risk-off tone overnight, with equity markets lower, the US 10-year rate dropping further, to around 1.30%, and the USD strengthening. There haven’t been any obvious catalysts for the shift in sentiment. In the UK, rates increased sharply after a second BoE MPC member spoke of tightening policy earlier. Commodity currencies have come under pressure amidst the risk-off backdrop, with the NZD dropping back below 0.70. NZ CPI is released this morning, with the market pricing around a 70% chance of an OCR hike next month.
There’s no single driver one can point to in explaining the more cautious investor sentiment overnight. The usual suspects, being concern around the delta variant, a possible slowdown in global growth, and fears that the Fed could tighten policy too early, have been variously quoted as reasons for caution in financial commentary. We suspect the overnight pullback in equity markets, from close to record highs it must be said, could be just as much day-to-day noise. The S&P500 is off 0.4%, the NASDAQ 0.8% and the Russell 2000 index of small cap stocks is down by 1.1%. The US 10-year rate has continued to drift lower and is now trading around 1.30%, 5bps lower on the day and close to its lowest level since February.
Chinese annual GDP growth came in slightly lower than expected, at 7.9% (8% expected), although quarterly growth increased to 1.3% in Q2 from a revised 0.4% in Q1. Monthly Chinese activity data for June was also better than expected, with upside surprises across industrial production, fixed asset investment and retail sales data, the latter an encouraging sign as the economy starts to rotate towards a consumption-led recovery. Still, markets appear wary of a slowdown in Chinese growth, with the recent RRR cut by the PBoC seen by some market participants as validating this theory. US regional manufacturing data overnight were mixed, with the New York Empire survey hitting a record high but the Philly Fed survey falling back, albeit to what is still a very high level on a historical basis.
Fed Chair Powell hasn’t provided much new information in his second round of his testimony to lawmakers, this time to the Senate. Like yesterday, Powell acknowledged that inflation had been higher than expected but reiterated that the Fed’s base case was that inflation would normalise once temporary influences faded. But he added that the Fed was monitoring inflation, including the risk that it could prove longer lasting and seep into inflation expectations.
In currencies, the USD is stronger across the board amidst more cautious risk appetite. The BBDXY index is up 0.3%, rebounding back to near three-month highs. The JPY (+0.1%) has outperformed given the risk-off backdrop and fall in US Treasury yields while the commodity currencies have been the laggards. The NOK is down more than 1% over the past 24 hours, while the NZD, AUD and CAD are all off around 0.8-0.9%. The AUD is trading just above 0.74, close to its year-to-date low. The NZD, which hit 0.7040 yesterday morning, has dropped back to around 0.6980, close to where it was before the hawkish RBNZ MPR.
In the UK, another Bank of England MPC member, Michael Saunders, has come out in support of an earlier tightening of monetary policy. Saunders, who has been one of the more dovish voices on the committee in recent times, said options included stopping its QE bond buying over the next few months “and/or further monetary policy action next year.” Such a tightening would be “more akin to easing off the accelerator rather than applying the brakes” he said. Saunders comments echo similar messages from fellow MPC member Ramsden yesterday and follow recent upside surprises to UK inflation, such that core CPI is now above the 2% target. Governor Bailey was noncommittal after the most recent CPI upside surprise, saying the Bank would analyse the extent to which is was being driven by temporary factors.
Saunders comments led to a sharp repricing of BoE rate hike expectations, with the market bringing forward the expected timing of the first 25bp rate hike to mid next year. The UK 2-year bond yield increased 6bps, to 0.13%, while the GBP immediately gained 0.5% in the wake of the comments, before later reversing. The market ignored a weaker than expected UK labour market report for May, which revealed slower than expected job growth and a tick up in the unemployment rate, to 4.8%.
There was little market reaction to yesterday’s stronger than expected Australian employment report, given it preceded the recent lockdown in Sydney. For the record, Australia saw 29k new jobs in June (+20k expected) while the unemployment rate fell from 5.1% to 4.9%, its lowest level since 2010. The market appeared more interested in news that the state of Victoria would enter a snap five-day lockdown after another 2 new Covid-19 cases were reported in Melbourne. The NZ travel bubble with Victoria has been paused for at least four days in response.
There was another chunky increase in short-end domestic rates yesterday, with the 2-year swap rate rising by 7bps, to 1.04%, as the market continued to digest the implications for the OCR outlook from Wednesday’s RBNZ MPR. August remains around 70% priced for a rate hike but the market increased rate hike pricing for November, taking it 4bps higher, to 0.66%, as the market edges closer to pricing two full hikes by the end of the year. Yield curve flattening was again the order of the day, with the long end of the swap curve kept in check by the overnight move in US Treasuries. The NZ 10-year swap rate was up just 1bp, to 1.85%. The yield curve, as measured by the difference between 2 and 10-year swap rates, is back to its flattest level since the start of the year, at 81bps.
NZ CPI is the highlight of the local session today. We are looking for a 0.7% quarterly increase, taking the annual rate to 2.8%, close to the top of the RBNZ’s 1-3% target range. The market will also closely watch the core inflation figures, which were already around the 2% target midpoint last time and are surely biased higher. The CPI data is, alongside the HLFS labour market report in early August, one of the two key domestic pieces of economic data ahead of the RBNZ’s August meeting. US retail sales data is released tonight with the market looking for a bounce back in core retail spending in June.